Feb 4, 2013

Liebreich: 2013 – Smoke Clears from the Battlefield: Many Casualties but Campaign Continues

The Battle of Borodino, immortalised by Leo Tolstoy in his epic novel War and Peace (or by Audrey Hepburn and Henry Fonda in the 1956 film classic, for you Americans) was the bloodiest battle of Napoleon’s invasion of Russia. Both sides took horrific casualties – 70,000 killed or injured among 250,000 participants on both sides. Napoleon won the battle but his troops were too exhausted to chase and destroy the Russian army. Although Borodino marked the high point of Napoleon’s Russian campaign, it also determined its ultimate failure. His Grand Army went on to occupy Moscow, but its eventual defeat, destruction and withdrawal was assured.

As 2013 opens, the smoke is clearing from the energy sector’s equivalent of the Battle of Borodino. The forces of clean energy have been pushed back, with painful losses, by a combination of economic conditions and fossil fuel’s new Imperial Guard, in the shape of shale oil and gas in North America. The battlefield is littered with dead clean energy companies, and more will die of their wounds in the coming months.

And yet, all is not lost. The drivers propelling the world to a cleaner energy system are, like Russia’s resources in fighting against Napoleon’s invasion, almost limitless. Coal and oil producers may have captured for the moment the economic high ground – profitability supported by the ability to externalise their costs and cement their position through political action. But this will not work forever, for all sorts of reasons, and in 2013 the fragility of the fossil fuel system is likely to become more, not less, evident.

Yes, it is the beginning of a new year, and time for my “10 Predictions”, made with the help of Bloomberg New Energy Finance chief editor Angus McCrone and our team of 80 specialist analysts around the world, covering every sector of clean energy, plus carbon, power, water and, to be launched officially in 2013, natural gas.

The predictions below cover the following: overall clean energy investment; shale gas; financial innovation; energy policy; solar; wind; bioenergy; electric vehicles; and – hold onto your hats – fuel cells. Overall, we expect 2013 to benefit from slowly improving economic confidence in developed countries: we are discounting the chance of total meltdown in the US debt ceiling negotiations in the spring, another temporary fudge seems more likely. Energy prices will remain high, and there will be ongoing tension around trade and currencies. And all of this is predicated on their not being any major geopolitical surprises – Iran, please take note.

As usual, we will audit the predictions in this column at the end of the year, celebrating what we got right and owning up to what we got wrong. Here goes…

1. RECOVERY IN CLEAN ENERGY INVESTMENT

Clean energy investment fell 11% in 2012, to $268.7bn – the biggest year-on-year setback since we have been tracking the figures in 2004 – but it looks like the main influences that caused that reverse will unwind during 2013.

Uncertainty over the US presidential election came to an end on 6 November. The threat of the expiry of the Production Tax Credit (PTC) for US wind was lifted at the turn of this year, when Congress extended the PTC for another year as part of its “fiscal cliff” deal. Of great importance, even though the PTC was only prolonged for one year, projects started but not completed before the end of this year will still be eligible, preventing the same race for completion. In the UK, at least some of the fog over Electricity Market Reform (EMR) has lifted, and 2013 will see the publication of the strike prices, which developers will be able to plug into their spread-sheets and take to their equity and debt sponsors. Germany has made some progress towards addressing the grid connection problems that stymied offshore wind investment for much of last year. China is moving towards clearing its twin backlogs of wind projects not connected to the grid, and unbuilt “megabase” wind projects. It also looks set to become the world’s biggest solar market.

On the stock market, clean energy share prices hit bottom in late July 2012, and have since rallied some 28% according to the WilderHill New Energy Global Innovation Index, or NEX. At around 130, it remains far below its November 2007 peak of 469, but I expect a modest recovery in valuations – as long as it is sustained – to be enough to bring about an increase in public market investment, from last year’s miserable total of $5.1bn (just 20% of the record of $25.6bn raised in 2007). One reason for thinking that this will happen is that the solar sector is getting closer to viewing the light at the end of the tunnel – seeing the moment when painful excess capacity gives way to something closer to balance between supply and demand. A sign of this is that polysilicon prices edged up in the first two weeks of 2013, after plunging again last year. If and when stock market investors regain a little appetite for clean energy, there will be no shortage of wind and solar manufacturers, biofuel technology developers and others queuing up to bolster their balance sheets with an equity issue.

Helped by resilience in wind and solar asset finance and small-scale project spending (see below), and by an upturn in public market activity, I expect clean energy investment in 2013 to end the year up from last year’s levels. Indeed I will stick my neck out and say I think investment in 2013 will be around 2011’s record of $302.3bn.

2. WORLD WAKES FROM SHALE GAS SWOON

International gas prices have rarely been so interesting, or so varied. For much of 2012, natural gas was two-and-a-half times more expensive in Europe than in the US, and four times more expensive in Asia than in the US. The US natural gas price was hit by a perfect storm, with a glut of shale gas hitting the market at a time of weakened economic activity, reaching as low as $1.80 per MMBtu in April.

Since then, however, US natural gas has roughly doubled to around $3.50 at the time of writing. A more normal US winter than last time should support prices at around this level. Going into 2013, we are seeing a reduction of activity driven by “Hold by Production” (HBP) contracts, by which you must drill or lose your lease. In addition the backlog of completed-but-unconnected wells is dwindling. This means that lower drilling activity should eat into the supply overhang by summer 2013 – and while production from the eastern US Marcellus field will continue to grow, this will be outweighed by declines elsewhere. Our gas analysis team expects the price to close out the year around $4 per MMBtu, although the country remains structurally oversupplied, so it will remain low and volatile until after coal retirements really start to bite in 2015.

The coming year will also see more data on the environmental impact of fracking – from water contamination to fugitive emissions – and on the economics, in particular decline rates. These issues are neither show-stoppers nor irrelevant; they are manageable, but their management will add cost to shale gas production. In short, 2013 should be the year when the US recovers from its infatuation with shale gas, moving into a rather more mature and nuanced relationship.

In Europe, meanwhile, spot gas will trade roughly flat year-on-year as declines in UK production are met with sluggish overall demand, as coal remains cheaper for generators and the European carbon price remains lower than low. The UK, and perhaps some other European countries, will resume work on exploiting shale gas, but this will do nothing to restrain prices in the short or medium term. If anything the results will provide data quantifying how much more expensive it will be than US shale gas – our preliminary figures show UK shale gas costing $7-$14/MMBtu, compared to $4-6 in the US.

In Asia, China will continue to consume (and produce) more gas, including its first shale gas, but the key to prices will be Japan. Attempts to revive nuclear generation will be slow to take effect – partly because new safety standards are not even due to be published until July. So, in 2013, the liquefied natural gas market in Asia will remain tight, and prices uncomfortably high.

3. FINANCIAL INNOVATION GROWS FROM A TRICKLE TO… A BIGGER TRICKLE

One of the main impediments to clean energy investment in the last few years has been continuing turmoil and uncertainty in the financial sector. First, banks were hamstrung by losses during the financial crisis; their ambitions for clean energy lending were scaled back – in some cases abandoned – as they shunned risk, stopped lending cross-border and worked to recapitalise themselves. Now well-meaning financial regulations such as Basel III and Solvency II are having the unintended consequence of forcing financiers to think twice about long-term lending to, or equity investment in, any sort of green infrastructure projects.

These sort of systematic biases in the financial system – and others such as pension fund fiduciary duties and liability-matching – will be explored in more detail in forthcoming Bloomberg New Energy Finance White Paper Financial Regulation: Biased Against Clean Energy And Green Infrastructure?, which will be published in the next few weeks.

A full solution to these problems can only come from the authorities rethinking some of their regulatory structures. However the financial sector has got some room for manoeuvre. We have already seen a number of innovative financial approaches in the past few years – from project bonds to peer-to-peer lending – and we expect to see more in 2013.

The big win would be for pension funds to invest in green infrastructure via project bonds (which are defined as a sub-set of corporate bonds, and therefore a core asset for pension funds as they seek to match their assets against future liabilities). Project bonds are a relatively familiar item of financing furniture in the US, where Warren Buffett’s MidAmerican Holdings, for instance, raised $850m in an over-subscribed issue nearly a year ago for its Topaz solar portfolio in California. In Europe, bonds have been caught in a chicken-and-egg situation – because there have been almost no issues, apart from the unfortunate Breeze wind portfolio bond sales in 2005-07, there is no track record to give confidence to ratings agencies or fund investors, and because of that shortage of confidence, no track record gets built up. However, I will stick my neck out and forecast that 2013 will see the beginnings of a new clean energy project bond market in Europe. The likelihood is that this will take the form of bonds for proven, operating projects, perhaps with some participation from multilateral financial organisations, export credit agencies or the UK’s Green Investment Bank.

In the US, we will likely see the first disclosed instance of some truly innovative approaches to funding using low-cost capital, most likely in the form of asset-backed securitisations and/or solar real estate investment trusts (S-REITs). The deals may not be as big as the Topaz bond issue, but they will merit even closer attention, since their focus will be on a segment with even stronger growth potential: small-scale solar.

There are a few other new sources of finance we expect to make increasing forays into the area of clean infrastructure during 2013. Among them sovereign wealth funds, Asian corporates and providers of Sukkuk finance. All of this will give the sector a lift, but do not expect the volume to exceed $15bn in total this year.

4. EUROPE FOCUSES ON ENERGY MARKET REFORMS

The European fiscal crisis – or more precisely the resulting deep recession – has exposed deep flaws in the structure of the EU-ETS. If the first phase was characterised by over-generosity of supply (some would say by emitters exaggerating their need for credits), there is a risk that, without strong structural reform, the second and third phase will be remembered for the evaporation of demand, and for the inability of the market to respond.

Without change, the problem of oversupply will continue to hang over the market for decades. The Commission may be successful in its bid to intervene in the market and “backload” the dumping of new allowances into some later period, but the price impact may be temporary and limited. The economics of coal and gas in Europe right now mean that only a far higher carbon price would exert real pressure on generators to switch away from the black stuff.

Meanwhile, the main preoccupation for European policy-makers in 2013 will be energy market reforms. Most headlines will be generated by the UK’s EMR, which although they form the official position of the Coalition Conservatives and Liberal Democrats, have defined a more fractious front line between the progressive and reactionary wings of the Conservative party.

The main preoccupation on the continent will be to stabilise the financial situation of the utility sector – with the big German utilities undermined by large volumes of renewable energy, and EDF still struggling to shore up the position of nuclear in Europe’s energy mix. Germany will spend the year convulsed in discussions of the “Energiewende”, or Energy Transition. Wildly popular until people realise that over half of their energy bills are driven by the cost of renewable energy feed-in tariffs and the associated grid upgrades.

Common ground between fossil and clean energy generators will be found in the idea of capacity markets – incentives to encourage the construction and operation of balancing (usually gas) generation to reduce base-to-peak electricity price volatility. Both the UK and Germany will start to introduce those kinds of incentives, but there will also be growing challenges to that approach – from those who argue that it can be left to market forces to arbitrage high and low power prices with the help of interconnection and demand response; and from those who argue that governments should do much more to encourage investment in storage technologies such as pumped hydro, batteries and other, more innovative options including demand response.

5. TECHNOLOGY, ENVIRONMENT AND DEVELOPMENT IN THE DRIVING SEAT

The most dynamic developments in clean energy will continue to take place outside Europe. In general these will be driven by technology, broader environmental or development concerns, rather than by any sort of climate imperative.

The US in 2013 will make further progress on achieving its pledge of a 17% reduction in emissions by 2020 (from 2005 levels), mostly thanks to the arrival of shale gas and the retirement of old coal plants, supported by a continuing rise in the share of renewable energy. The main innovation will be in California where previous uncertainty will dissolve with the state emerging as the leading carbon trading scheme in the world. Prices will be significantly above those on the other side of the Atlantic, at around $14 per tonne (EUR 10.5/t).

Meanwhile, in the US, the Environmental Protection Agency will move further into the vacuum created by continuing deadlock in Congress on emission control and clean energy legislation. The EPA will extend its regulatory tentacles on CO2 this year, both directly via its enforcement of the Clean Air Act regulations, and indirectly via rules that curtail the emissions of particulates from the ageing US coal fleet. The improving efficiency of the US vehicle fleet will continue to surprise.

In Asia, the main drivers of clean energy will be Japan’s ongoing attempt to meet its energy needs without restarting the bulk of its nuclear reactors, and China’s need to deal with its pollution problems. The most surprising aspect of China’s recent air quality scandal was not that Beijing suffered from an extreme level of PM2.5 particulates – we all knew that – but that official figures were released confirming in real time just how bad the problem was. Expect a raft of new announcements, including controls on vehicle emissions and the closure of more coal-fired power stations.

Meanwhile, in the developing world, more countries will see domestic clean energy as an essential enabler if they are to continue down the path of rapid economic development without becoming dependent on imported fossil fuel. Fossil fuel exporters, particularly in the Middle East, have finally understood that energy efficiency and renewable energy free up more of their resources to earn export income. 2013 will be the year that they start to build clean energy at scale.

6. CHINA, AFRICA AND LATIN AMERICA TO DRIVE SOLAR GROWTH

Solar was more dominant than ever before in the clean energy investment total in 2012, accounting for $142.5bn out of $268.7bn, or 53%. That would be remarkable to a time traveller from 2006, when it ranked third behind wind and biofuels, and made up less than a fifth of the total. I expect solar to maintain a similar share in 2013.

Overall solar investment should beat last year’s levels by a small margin – despite the fact that 2013 system prices will be lower than those of 2012. However the most important features of the year will be geographical change. The old reliance on a couple of big European markets will fade further in 2013, and I expect to see rapid growth in both large- and small-scale PV deployment in China, enabling it to overtake Germany as the largest solar market. Beijing, suffering from smog and particulate levels some 30 times those in New York, will turn its focus towards PV projects that connect to the local distribution network, stimulating around 8GW of capacity addition in China this year.

Also on the up will be sub-Saharan Africa, one of the few regions not putting up trade barriers in the solar sector. We expect at least 1GW of new, large PV projects to be financed by year-end, making use of development and export-import bank finance. We also expect to see action pick up in distributed solar-based systems, both in Africa and India. In South America, the fastest-moving countries will be those outside Brazil where policy mechanisms are evolving and sunshine is plentiful.

China’s strong appetite for PV panels, and a bottoming out in module prices after the vicious deflation of the last four years, will not be enough to save all of the world’s remaining solar manufacturers. We expect to see further bankruptcies, and emergency consolidations, as the shake-out continues. Equally, though we will see the leading companies continue to add low-cost capacity in a push to maintain market share.

7. INSTALLATIONS BECALMED BUT FINANCING PICKS UP FOR WIND

The second half of 2012 was brutal for the wind industry. In the US, the financing of new projects practically stopped outright in the second half of the year because of policy uncertainty; Europe remained in the doldrums because of its ongoing financial crisis, and China stalled as it struggled to swallow the bolus of projects announced in the past few years. The market will take time to recover in 2013, and overall wind installations are likely to be about 10% down on last year, at just over 40GW. However, financing activity should revive, helped by the new lease of life for the US PTC, so that wind asset finance should surpass 2012′s figure of $76bn (the record was $92.3bn in 2010). This will foreshadow better times ahead in terms of installations in 2014 and beyond.

New methods of financing – mentioned in prediction 2 above – should help to cycle money back into development and construction, and the economics of wind should continue to improve as the prices of turbines are competed down – particularly those of new models, which have held up quite well so far – and developers push hard on operation and maintenance costs.

8. BORING BIOENERGIES MAKE MONEY

Pellets will mostly be used in large converted power stations. Last year saw several positive developments – European markets aligning their policies, shipping ports on the east and west coast of North America emerging, the build-up of handling capacity, and large utilities reshuffling their positions at the starting gates. This year, it is time to cash in.

We will see an additional 2GW of renewable dispatchable capacity in the EU-27 (ie biomass), producing electricity at competitive prices. In the past three years, pellet imports have increased by a third each year. In 2013 they will double. At EUR 135-a-tonne, it will be a EUR 300m market – with more growth potential for 2014. Supply will come from the North American basin, with some odd sources in Russia and possibly Brazil. If the industry is clever it will nip any sustainability controversy in the bud by being proactive.

Environmentally speaking, wood pellets are not as clean as the driven snow – but if produced and procured correctly, they are a cleaner alternative to coal. Dedicated biomass plants with more than 80MW capacity will remain a pipe dream, and we think more developers will shelve their plans. The future belongs to large coal conversion plants that import wood pellets, medium-size plants around the 25MW mark that can use local feedstocks like straw, and small-scale 50kW CHP plants built by industrial users.

In biofuels, the relatively “boring” Brazilian ethanol sector should also gain in 2013, from low feedstock prices after a bumper sugar harvest. In the US, by contrast, a poor corn harvest last autumn will keep ethanol prices high, to the detriment of demand for domestically produced biofuel but potentially to the benefit of Brazilian imports.

9. ELECTRIC VEHICLE SALES SHOW SPARKY ACCELERATION

Sales of EVs roughly doubled in 2012. We expect the same again in 2013, to take shipments to around 200,000 worldwide, still a long way below annual manufacturing capacity, which will hit 650,000 cars by the end of this year. Plug-in hybrid electric vehicles (PHEVs) will continue to be more popular than pure battery vehicles, or BEVs, by a rough 60-40 split. Discounted leasing rates will be a major driver for EV adoption, particularly in the US where 70% of BEVs are leased, not bought. Among the notable new models due to be launched this year are the Honda Accord Plug-in, the Cadillac ELR and two from BMW, the i3 and i8.

The line between hybrids and EVs will continue to blur, with more flavours of micro-hybrids and mild PHEVs emerging. Lithium-ion battery technology will start to take over from nickel metal hydride batteries in hybrid cars. Among micro-hybrids, auto manufacturers will increasingly choose supercapacitors or lithium-ion batteries in place of lead-acid batteries.

10. FUEL CELLS – A RAY OF LIGHT AFTER DECADES OF SMOKE

You have to go back a decade or more to the last time fuel cells were a fashionable part of the clean energy sector. In early 2000, the share price of Canadian hydrogen fuel cell maker Ballard Power Systems reached $144.94. At the time of writing, they are at $0.675. However, fuel cells are finally on the move again – even if Ballard shares are in the basement.

Our analysts forecast that in the US, at least 50MW of new stationary fuel cell projects will be commissioned in 2013. This compares to a figure for active cumulative capacity of 105MW at the end of last year. Meanwhile, South Korea will double its commissioned fuel cell capacity to reach 100MW by the end of 2013, and in Japan the number of residences equipped with micro-CHP fuel cells is expected to reach 60,000 by the end of 2013.

This year, FuelCell Energy of the US and Germany’s SFC Energy will race to become the first independent fuel cell manufacturer to become profitable (in real terms, not just due to an accounting quirk). Bloom Energy may consider an IPO towards the end of 2013, depending on market conditions and successful completion of existing projects, including the 30MW Delmarva utility-scale undertaking. Fuel cells will also continue to make inroads in developing countries as a back-up/auxiliary power source for telecom towers.

Manufacturers such as Toyota and Honda will release prototype fuel cell vehicles, or FCVs, with an eye to commercialisation in 2015, but this timeline will most likely once again prove over-ambitious. Hyundai plans a commercial launch in 2013, but that may well prove a challenge. In the meantime fuel-cell forklifts will continue to make inroads into the market – selling 15,000 units by the end of 2013.

* * *

Well, there we are – 10 Predictions for 2013. These are, in fact, a heavily edited sample of a much larger number of early-year thoughts from our analyst teams. We shall be publishing some of the more detailed ideas separately, for the benefit of our Insight subscribers, in the next few days.

If we are right, like the Russian army, after a bruising few years the forces of clean energy will spend 2013 regrouping, re-equipping and consolidating their positions. The fossil fuel sector has certainly been buoyed by recent advances in shale oil and gas and by carnage in the European carbon markets, but it faces severe structural challenges, at least outside North America. With patience and time, 2013 could mark the start of a very positive phase for the clean energy sector. As Russian Field Marshal Kutuzov (in the film of War and Peace) says of Napoleon’s forces: “The Grand Army is wounded, but is it mortally wounded? An apple should not be plucked while it’s green. Patience and time.”

Which leaves me to say two things. The first is to mention our annual Bloomberg New Energy Finance Summit, to be held on 22-24 April in NYC; details of how to register can be found here: http://about.bnef.com/summit/. The second is to wish you a happy and prosperous 2013.

INSIGHT, DATA & NEWS ON THE TRANSFORMATION OF THE ENERGY SECTOR.
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